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CREDIT POLICES AND THEIR IMPLICATIONS FOR AGRICULTURE Remarks by Chas. N. Shepardson, Member, Board of Governors, Federal Reserve System, at meeting of the New England Agricultural Economics Council, University of Connecticut, at Storrs, Connecticut, on June 27, 1957. The subject assigned to me might be interpreted in either of two Wa ys: Ca (1) the implications of national credit policies, or (2) the impli- Uons of credit policies of individual lenders. CUs I shall undertake to dis- s both phases. First, let us consider the role of the Federal Reserve System and its ^eans of effectuating credit policy, the factors entering into the deter- N a t i o n of policy, and policy itself. Congress has delegated to the System the function of regulating the f low o f the c r e d i t and money. These powers are used by the System to achieve broad objectives of stable growth in output and employment, stable pur- g i n g power of the dollar, and rising standards of living. Sound credit and monetary policies can help restrain inflationary forces during an upswing, Gnd also during periods of intense utilization of resources such as the pres- ent - Sound monetary policies can also encourage spending and promote economic ^covery during a recession. Monetary policv, however, cannot be expected 4. 0 do poi the entire job of promoting stable growth by itself. icies are very important. at,in Federal fiscal So, also, are a host of other influences oper- 2 on the economy, including labor-management relations, cost and profit ^ g i n s , productivity developments, and business and consumer attitudes in general. Within our institutional framework, however, monetary and credit - 2 - Policies constitute the principal tool for promoting sustainable growth in complex economy and at the same time maintaining the value of the dollar. Federal Reserve policy seeks these results by influencing the availability and cost of bank reserve funds. in As you doubtless know, member banks the Federal Reserve System are required to keep balances with the Reserve in their district equal to a prescribed percentage of their deposit liabilities. The volume of reserve funds available to the banking system aric * the cost of obtaining those funds have an important influence on the Su PPiy of bank credit available to the public and on the cost, or rate of Merest, which borrowers have to pay for it. In this way, the authority of Federal Reserve System to regulate bank reserve positions enables the Ostein to exert considerable influence over the tctal flow of money and Cre ^it through the markets of the economy and over the level of spending in th °se markets. The Federal Reserve Svstem has three principal instruments for in- f f a c i n g bank reserve positions. Snd c The most used instrument is the purchase sele of securities, mainly Treasury obligations, in the open market, °%only referred to as "open market operations." A purchase of securities "the System Open Market Account adds to bank reserve funds and bank deposits, arici tends to encourage credit and monetary expansion. A sale of securities, Aw other hand, reduces reserves and deposits and tends to restrain credit ^ Monetary expansion. Such purchases and sales provide our most flexible and frequently USeci instrument of monetary and credit policy. They are adaptable both for - 3 taking minor adjustments and for effecting major shifts in bank reserve posie s , and they are easily and promptly reversible if the situation requires. addition to their use for regulating the volume of reserves as needed in v ie;-j 0 f the general economic situation, open market operations serve as the l!lRans ' by which the System ordinarily provides for the seasonal rise and fall reserve needs for credit. They are also used from time to time throughout th 16 Year to offset what otherwise might be the disturbing effects of shorter- ^ fluctuations in the supply of reserves. A second instrument for influencing member bank reserve positions ls the discount mechanism. The Federal Reserve Act makes provision for member to obtain additional reserves by borrowing from the Reserve Banks either their customers' notes or by obtaining secured advances. ifit-discounting Gre st rate charged for this service is known as the discount rate. The Borrowing at the Reserve Banks is regarded as a privilege rather a right of Federal Reserve membership. '^ily ju on a It is intended to be used pri- temporary basis to tide banks over periods of unusual drains of It is not intended to be a continuing source of funds and extensive o continuous borrowing is discouraged. In periods x^hen demand is outrunning and System policy calls for restraint on bank reserves, the discount e ttay be raised to keep pace with market rates in order to discourage other ^ necessitous bank borrowing, thus causing banks to adopt more restrictive ° Qn and investment policies. ic^ e si On the other hand, in periods of lagging demand, facilities or rising unemployment, when the System feels that credit ex°n should be encouraged, it provides additional reserves to the banking - h - Ostein by open market purchases and may also lower the discount rate. With bank reserve positions eased and.with their cost of borrowing reduced, banks encouraged to expand their loans and thus stimulate spending and employment. The least frequently used instrument for affecting bank reserve p0s itions is the Board's authority to change member banks' reserve require- ^ s , the percentage of outstanding deposits which member banks must keep ln ^ e form of a balance at the Reserve Bank. An increase in these require- ^nts tends to have a restrictive effect on monetary and credit expansion in 311 Gff banks, while a reduction in requirements tends to have a stimulating ect. Since these reserves form the basis for a multiple expansion of bank C3red it in all member banks, changes in reserve requirements provide a power- ful instrument, suitable primarily for longer run adjustments in the need foi% Reserves or where an immediate sharp impact on monetary and credit con- dn, OJ -ons i s essential. System credit policy must be geared to the ebb and flow of economic act ivity. Hence, to understand the implications of credit policy at any time it is essential that we also have in mind the economic situation at t h e time. For that reason, I would like to review current and recent ecor >omic developments as a background to present credit policy. Let us begin by taking a brief look at the current situation. Picture is of a strong, vigorous and resilient economy. The Over-all ec °nomic activity has been on a high plateau since late last year following 0 years of strong expansion. G Price structure have occurred in recent years notwithstanding the emergence Expansion in activity and upward pressure on - 5 - from time to time of soft spots with accompanying downward readjustments, su ch as in automobiles and housing. Most recently business concerns have lifted from accumulation to some liquidation of stocks. Final demands for goods and services, however, continue strong and resources of manpower and machines are generally intensively utilised. Unemployment currently amounts about h per cent of the civilian labor force, about the same as the post- to far average. While average prices of industrial commodities have been stable since February, consumer prices, significantly, have continued to rise and are now 3.6 per cent higher than a year ago. Prices of farm products have firm over the past year at a level somewhat above the low reached in late 1955 and early 1956. in Demands for credit are strong both at banks and the long-term capital markets and interest rates have advanced further. Industrial capacity has increased steadily and rapidly in recent Ve ars. plie with capacity up and with business demands for inventory down, sup- s of major materials are in general more adequate than earlier. The ^deral Reserve Board's index of industrial production had edged down a bit decent months but, in May, at lU3 per cent of the 19h7-h9 average, was in lightly higher than a year earlier. ch an ge f r o m the May level. The indication for June suggests little The labor market has continued stable. Nonfarm ^loyment in May at 52.6 million persons was little changed from December but was 750,000 higher than a year earlier. Output per manhour in the man- ufacturing industries, which changed little from early 1955 to mid-1956, has Ruined its noticeable upward trend and labor unit costs have tended to level - 6 - Meanwhile, the dollar value of total output of goods and services h *s continued to rise to new highs, in part reflecting higher prices. fir In the st quarter, gross national product rose to an annual rate of $);27 billion, ^ billion, or S S per cent, higher than a year earlier. Another moderate Urease in national output has apparently occurred in the current quarter anc * the total is likely to exceed an annual rate of $1*30 billion. Recent expansion in gross national product reflects moderate increases ln expenditures in most major areas of demand. Consumer expenditures for non- durable goods and services have continued to increase. Outlays for durable in the first half of 195'7 are larger than in the first half of 1956, Electing in large part higher prices for new automobiles. Extension- of lns talment credit for financing purchase of automobiles has recently been m j t to the record rate reached in the summer of 19bbWhile business has shifted from accumulation of inventories at an rate of billion in the fourth quarter of 1956 to liquidation of bj -llion in the first quarter of this year, spending for plant and equipis continuing to increase from very high levels, although the rate of *dvance is much sloxver than earlier. ri11 The latest Commerce-SEC survey of non- business intentions to spend on fixed capital indicates an annual rate Of E n d i n g of $37.9 billion in the third quarter of this year, up $600 million £ !a 0f the estimate for the current quarter and $2 billion from the third quarter ^56. Currently, the largest increases are in spending by public utilities arid ^ilroads. Manufacturing concerns plan a decline in spending in the third following two years of substantial increases. Total outlays for new construction so far in 3.957 have been slightly al >ove a year ago. Increases in publicly-financed construction and in most •types of business construction have more than offset reductions in residential building. In May, however, private housing starts seasonally adjusted r s ° e.to an annual rate of 990,000 units, the highest so far this year but ^ Per cent below a year ago. at In the first five months of 1957, starts were an annual rate of about 9?40,000 units compared with 1,11*0,000 in the year ^>6. The decline in starts has been concentrated in units under VA financing] number of conventionally financed units is about the same as a year ago. State and local outlays for construction and other purposes have ri sen steadily and are scheduled to rise further. an Federal purchases of goods 3 services have increased since mid-1955 and are also likely to rise in year ahead, despite strong efforts towards economy. Meanwhile, activity abroad continues to expand in most industrial Entries and upward pressures on prices persist, Our exports continue to the very advanced first quarter level. Taken altogether, many recent developments have been gratifying. ese e r include the resumption of significant productivity gains, the halt in ise of industrial prices, and more cautious business inventory policies. put es i employment, and consumption have remained at advanced levels. s, periods like the immediate present — Never- with their high levels of eraa ttds -- give rise to difficult economic problems. Increased productivity is a principal key to our established pattern c °Uomic growth. Our standard of living, either as individuals or as a ftatin ° > depends primarily on the amount of usable goods or services which - 8 Ve produce per manhour of human labor. - It is also dependent, however, on ^e maintenance of an aggregate purchasing power which is kept in balance available supply. This is best illustrated by the contrast between ^ l o p m e n t s of the past few years and those of the In 1939 we were still suffering from the inertia brought on by deviating effects of the world-wide depression in the early '301s. tot al national income of .^72.8 billion. 17 p e r c e n t 0f t h e labor force. We had a Unemployment was high, amounting to Per capita income and consumer buying were still below 1929 levels and prices generally were depressed. From to 1951 war, postwar and Korean demands were pressing capacity to the ^rn-it or beyond and resulting in inflationary price rises. tise th Some of this price Was perhaps unavoidable in view of the extraordinary demands of war on Nat ion's resources, but some of it may also be traced to the practice of Egging Government security prices, thereby barring an effective policy of restraint. In early 1951 came two changes. The peg was removed fol- the Treasury-Federal Reserve accord in 1951 and the stimulus of heavy iC:i -patory buying by consumers and business ended. From early 1952 until late 1955 we were in a period of relative Stab iHty i n consumer and industrial prices. The decline in activity in the Cori d half of 1953, resulting mainly from large reductions in defense spend- ing w as moderate. Unemployment was relatively low and disposable income ^nued persistently. high. Prices of farm products and income of farmers, however, - 9 - In recovery developed into a strong boom. ^d easier credit spurred consumer demand. Wa Exuberant optimism To expanding consumer demands s added an upsurge in business spending for plant and equipment. With the federal Government continuing to take a large portion of the national output, th e price structure was under heavy pressure. In this situation we had a cb °ice between two courses, neither of them universally popular. One would the extension of credit to meet all demands even though it would create lending power in excess of current capacity to produce. to This would lead another round of price increases, overexpansion, and possibly ultimate def lation. It would also mean more inflationary spending at the very time we should be encouraging saving to pay for the increased productive Ga Pacity essential to our continued growth. The other course would attempt to h old expenditures to a level permitting a prudent expansion of production fa °ilities and a sustainable rate of growth in current consumption. C This ° Ur s e should be familiar to any farm group for the farmer has always recogthe necessity of holding back a part of this year's production for ^utUre replacement or expansion. Just a few years ago we saw the folly of departing from this concept the beef cattle situation. In the face of a booming demand for beef, C l e m e n decided to expand, new men went into the business and both groups V l t or enlarged their herds at the expense of current consumption. tinie this looked like good business. For a But while the continuing urge to expand ^gravated the shortage and boosted prices, this increase in prices was gradcurtailing demand and per capita consumption dropped from about 63 in 19)47 to $$ pounds in 1951. As the production from these new and - 10 - enlarged herds began to hit the market, we found that supply bad outrun effective consumptive demand. This, coupled with drought and other factors °aused a cessation of this expansionary trend and cattle prices dropped Nearly 50 per cent in three years' time. Of course, no one wants rampant inflation or the resultant deflation. However, seme people seem to feel that a mild or creeping inflation is toler- ab le or even desirable and that in any event it is inevitable. tio Such a posi- n is self-defeating since persistently rising prices carry with them a Widening expectation of further rise. This, in turn, leads to financial commitments, speculation, misdirected capacity, slackened efficiency, °sion of existing savings, discouragement of new savings, and ultimate col- er ^Pse, loss of confidence and depression. It is this sort of situation that must be guarded against in our en Ure economy at the present time. To accomplish this end, the Federal Reserve System has been following a policy of limiting credit expansion in °rcier to prevent excessive borrowing from undermining the stability of the ^onomy and the value of the dollar. the Reserves have been adjusted to meet seasonal needs of agriculture and industry, although not in amounts to ^et the desires of all potential borrowers. In these circumstances, banks found it necessary to meet a part of their reserve needs through in^ a s e d borrowing at the Reserve Banks at rates that have risen gradually fl> om 1-1/2 per cent in April 1955 to 3 per cent at the present time. These actions have placed banks under increased reserve pressure atlci have induced them to adopt more prudent and selective loan and invest- ®nt Policies. As a result, rates of growth in bank credit and in the money - 11 - su pply have been relatively small and interest rates have risen sharply, Electing the limited availability of funds relative to the demand for them. Here I would emphasize that the policy of restraint which has been Allowed has been one of retarding the rate of growth in the money supply, father than one of reducing the actual supply. As a matter of fact, the tooney supply is still growing though at a reduced rate of about 1 per cent a year compared with a rate of 3 per cent in 1 9 ^ . It should be noted that, ^though growth in the money supply has been smaller than usual, the rate of tl rn ' °ver of each dollar has increased considerably. Now, let us consider the implications of this policy for agricul- ture. f a r m e r t s future depends on a sustainable growth, a high consumer P h a s i n g power, and a balance of production to effective demand. Any over- Mansion leads temporarily to inflation and ultimately to deflation. The of agriculture over the years is fraught with painful examples 0f this situation. As you well know, during most of the past several years price and ^ o m e trends in agriculture have been counter to those in most of the noneconomy. It is not uncommon, however, to have such divergent trends in <J -0Us segments of an economy as vast and complex as ours arid policy makers n System, as elsewhere, must appraise all of these divergent trends in lv ing at a conclusion as to the general direction of the economy. The declines in farm prices and incomes in recent ^/ears, for the Part, appear to have been adjustments to the progressive increases in ai*rn Production and to the declines in foreign takings from their postwar father than any indication of xvreakoning in consumer demand. - 12 - There is a marked difference in the present situation compared with ^at in the '30's. Then we had loss of confidence, business and industrial stagnation, burdensome unemployment, and lack of consumer buying power. Today we have the reverse. 13 Employment is high and consumer purchasing power at record level. Here, then, has been a dilemma. On the one hand, business and industry have been booming, wages and prices have increased, and inflationary Pressures have continued to manifest themselves. On the other hand, agri- Cu lture has been caught in the throes of overproduction and deflation although change in trend in recent months seems to indicate a definite inprove- ^ t in that situation. This means that our agricultural problem is primarily ° ne of adjustment in our farm output rather than one of stimulating the geneconomy, For the economy as a whole, a cautious restraint of inflationary tendencies is still in order. tlle farmer. Certainly, inflation would be of no help to Since his price problem is definitely one of surplus supply ^ther than lack of consumer buying power, inflation would be of little help him in terms of increased selling price, especially for commodities that are Prj in surplus, and it would definitelv be a detriment in terms of increased oes things he has to buy both for production and for his oxm use. on the On balance, the answer seems clear. fla ti on e on the The detrimental effect of in- cconomy as a whole and on the rising costs of production to farmer far outweighs any disadvantage that he mav suffer from credit *Gstraint. As you doubtless know, credit costs to farmers average something - 13 le ss than five per cent of total farm costs even with the rise in farm debt last year. It therefore seemed preferable to accept some reduced avail- ability of farm credit and some increase in credit costs if we could thereby ^strain inflationary pressures that could only result in further increases the other 95 per cent of farm costs. As a matter of fact, we have found little evidence of reduced availa bility of farm credit for credit-worthy farmers. The continuing rise in f arm land prices in practically all sections of the country would not indi- cate any lack of farm mortgage credit. Furthermore, available information ° n interest rates indicates that rates on farm loans, both real estate and n °n-real estate, have risen less than in other sectors of the economy. Of course, some people will claim that rising money rates are not 0nl y adding to the cost of farm credit but that they are also a factor in tlle rise of all other farm costs. tl)e rise in costs would have been without some credit restraint, tlle history of inflation in periods of unrestrained credit expansion in tllis My answer is that no one can tell what However, and other countries gives indication of what it might have been. And now let us turn to the implications of credit policies of local Meters. Within the broad constraint of general credit policy, individual. have considerable scope to determine their particular lending practiC e s tin n and standards. Agriculture has gone through a technological revolu- « in recent years. • Since 19U0 production per acre on all crops has in- G ased 22 per cent and on livestock 27 per cent per breeding unit. e 1 Period, output per manhour has almost doubled. In the - Ill - VJhile this increased productivity of labor has been the key to the rising standard of living throughout our economy, it has special significance ^ the credit problems and policies of farmers and farm lenders. These prob- e s stem from the fact that increased productivity is primarily the result of the substitution of capital for labor. For example, land and animal, pro- activity is being increased by the use of improved seeds, feeds, and breedin S stock and more and better fertilizers, insecticides, herbicides, and other ^ c u l t u r a l chemicals, together with the increased use of purchased power in the form of fuel and electricity. Of course, this increases cash operat- e s costs,and per capita operating capital requirements for these items rose ^om $ 7 £ 0 in 1 9 h 0 tQ |2522 in 1956. More and better power and machinery increase the number of land and ^al u n its that a man can handle but they called for an investment of •k>?ii8 i n 1956 compared with $220 in 19U0. lead This ability to handle more land s to fewer and larger farms and land investment per worker rose from to $10,793. In the aggregate, this amounts to an increase in invest- Per worker from $3,631 in 19U0 to $15,163 in 1956, part of which of °°Urse reflects the rise in prices and depreciation of the dollar duving this ^iod. Commercial farming, on which we depend for most of our agricultural A u c t i o n , has become big business and requires sound business methods both P a g i n g and in financing the operation. h Unfortunately, not all farms * Ve attained a satisfactory level of efficiency. ^ H o n farms in the Out of approximately U.8 country today, about one-third might be classed as -15 - "commercial" farms, producing about 85 per cent of our farm commodities. About one-third are what might be classed as residential farms whose owners are largely or entirely dependent upon off-farm income. is a The remaining third made up of marginal or sub-marginal farms, many too small to provide even minimal standard of living, and the owners of which have little or no off- far m income. In a way, it might be said that it is this group that is at the r °°t of our whole farm problem. The cost of production per unit on these Snia:i -13 poorly equipped farms is so high as to be unprofitable even at prices above those now prevailing, yet even their relatively small part of ^tal farm production contributes to the surplus and the consequent depression all farm prices. A farm operation that obviously cannot produce a fair return on the Vestment over a reasonable period of time is a poor credit risk for borrower lender alike. The borrower will either sink further in debt or he m i l himself and his family to drudgery and poverty. In either case, the £ will have lost part or all of his equity, the banker will have lost a 0Ust The °mer, and the community may have lost a potentially productive citizen. operator of such a farm, if he lacks the talent or resources to alter or er) large his operationj micht better bo denied credit and encouraged to seek othpv, uses for his talents and resources. Our principal farm credit problem is with the capable and experienced ° Perat or, large or small, who needs to enlarge or alter his farm program so as + Provide a more efficient utilization of his labor and equipment and a gross and net income. This may call for a full-time operation or a - 16 - Part-time one with time available for some off-farm employment. Ca In either se it will probably require increased extension of credit and probably on longer terms. With the increased capital requirement in many types of farm operations, he may find it advisable to continue to operate indefinitely on a certain amount of borrowed capital. In fact, many of our better tenants fi nd it more profitable, with fair rental contracts of long tenure, to con- tinue to rent and conserve their available capital for equipment and operations rather than to tie it up in land. In no event should the farmer tie Up so much capital in land or so much of his income in the payment of land ^ t that he lacks operating funds to enable him to operate efficiently. In addition to his land, he may require considerable sums for inVe stment in livestock or equipment. of Breeding livestock pay out over a period years and not only require but justify longer term credit than feeder Restock which can be fattened and marketed in a matter of months. A man §oj -ng into dairying, for example, must have a certain minimum herd to justify the equipment and production facilities essential to the production of Grade A If he is burdened with unduly onerous payments on his cows and equiphe may curtail feed and care expenditures only to find that he has cut 131 Auction and hence his whole debt payment potential. Likewise, some cf the major farm equipment with productive life of Sev eral years may well merit longer credit terms than have commonly been tended, if there is justification for extensions of 30-month terms and cent down payments which are becoming increasingly common on automo^ e s , perhaps longer terms than commonly prevail would be justified for such - 17 th ings as tractors, combines, and other harvesting equipment in the hands of &°od farm operators. Of course, any mention of terms on agricultural loans raises the question of the hazards in farming. Having spent close to thirty years com- ba.tj.ng the droughts, floods and insect hazards of Ter-'.s, to say nothing of the vagaries of the market, I am well aware of this problem. This awareness, however, only strengthens my conviction that there must be more long-range ^siness planning in our farm operations. This planning should include s °und analysis of each enterprise, including projections of income and expense, Provision for adequate reserves in favorable years to tide over the poor years, anci a realistic appraisal of the adequacy and adaptability of the man and hl*s plant to the operation contemplated. Unfortunately, many farmers lack the training or business experience to ttake such an analysis. basi They seek credit as they need it on a piecemeal s and frequently from several different lenders, including banks, mort- i s lenders, equipment dealers and suppliers. ^ e total operation in such a case. Ho one lender has a picture Each depends primarily on the integrity the borrower and the adequacy of his collateral with little attention to th 6 debt repayment prospects of the farm as a whole. The government is attempting to meet this problem through the super- Visi X ^ ° n and guidance extended by Farmers Home Administration to its borrowers. sure, however, that we would all prefer to sec the need for government ^ d i n g reduced rather than expanded. th0 This,then, presents a challenge to commercial banks and I am glad to say that a gradually increasing number - 18 - °f banks are establishing agricultural departments to handle this problem. far, this activity has been limited mostly to the larger country banks. Th e smaller country banks feel, and frequently with justification, t\ at th ^y cannot afford a competent agricultural credit man. on Many city banks, the other hand, feel that they have little direct farm 1 oan business and hence no need for such a man. I would like to suggest that many city banks might find that the sstabliehment of an agricultural department to serve their country correspondents would be a profitable investment in more ways than one. 1 In fact, know of one large city bank with a strong agriculture department that has ^cked up enough trust business involving farm estates, both of its own and country correspondents' customers, to more than pay the cost of the dein addition to the increase in its participation-loan business. I would also like to suggest that these changing credit needs of and the corresponding need for changes in credit policies of fariT1 tlle lenders point to the importance of more attention to these problems on Part of our agricultural colleges. The growth of agricultural d.opart- in our banks is limited in no small part by the lack of men trained Xa farm management and farm finance. In too many cases our county agents, National agricultural teachers, and other agricultural workers may have *CceUent training in technical production and yet be poorly equipped to *sist farmers with their problems of organization, management, and finance. I realize that more training in this area may call for curricular ^isiong in many of our colleges but, as a former Dean of Agriculture trained Production, I would urge that you continue to press for greater recognitl ° n of this need.
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